Dollar - a world currency on demand?

The dollar is still the world's monetary anchor. This is also why the West was able to do so, Russia is tough because of the Ukraine invasion, global financial sanctions.

However, there are now some signs, that dollar dominance may be coming to an end. There are three main factors, which raise doubts:

Inflation can permanently damage international confidence in the value of the dollar. Consumer prices in the USA are currently rising at a rate of eight percent - and the trend is increasing. America is overheating.

This is what matters now, how determinedly the US Federal Reserve is taking action against it. (Watch out for the Fed meeting on Wednesday.)

The sharpest weapon in the Russia sanctions arsenal is the freezing of Moscow's currency reserves at other central banks, a step, which has not existed in this form before. Should fears arise as a result, that Washington can have currency assets confiscated at any time, This is likely to cause massive damage to the dollar.

The economic power tectonics are rapidly shifting as a result of Russia’s aggression – away from US-inspired global institutions, towards a new bloc formation with fragmented financial markets. It wouldn't be surprising, if this change were also reflected in the currency market.

Admittedly: Discussions about a decline in American super money have been going on for more than a year 50 years. And there were certainly enough reasons: 1971 the Bretton Woods system fell apart, in which the other western currencies around the (Back then it was still covered in gold) Dollars circled as the central star. This began the phase of the “great inflation”. That ended, when the Fed raised interest rates extremely in the early 1980s, causing global turbulence. In the 1980s, the USA transformed from the largest creditor to the largest debtor in the world - this did not affect the global status of its currency. Alternatives to the dollar were considered: In the 1980s, Japan's economic rise seemed to suggest a strong international role for the yen. At the end of the 1990s, a competitor emerged for the first time with the euro, which was based on a similar large economy.

All of these developments have decimated the role of the dollar? Not really.

But then the upheavals became more severe: The global financial crisis 2008 had its origins in the US financial system. 2011 The rating agencies downgraded the creditworthiness of the USA: At that time, Washington lost the top grade of AAA, which Germany, for example, still enjoys. Political polarization increasingly paralyzed Washington, so that the government repeatedly reached the statutory debt limits and many federal agencies had to temporarily stop working (»Government Shutdowns«).

Donald Trump's presidency ends 2017 may have been characterized by constant attacks on the democratic institutions of the United States, while at the same time China's rapid rise as a leading power challenged America's uniqueness. Everything doesn't matter. The dollar remained the monetary center of the world economy.

America's money leads, to date – with shares of around 60 percent of global foreign exchange reserves and internationally outstanding debt, 55 percent of cross-border bank loans and more than 40 percent of the foreign exchange market- and commercial transactions.

America may not be loved everywhere, It is already its currency. The euro is by far only number two in most disciplines, other currencies play practically no role, like the European Central Bank (ECB) has precalculated.

So far, everyone in the world has invested their money in dollars, especially in times of crisis. Currency Made in USA is considered a safe haven and ultimate store of value. Ultimately, this is based on confidence in the American economy, their institutions and the rule of law. There are also network effects, which also have a stabilizing effect: The dollar is also a reserve, Attachment-, financing- and transaction currency. Highly liquid foreign exchange markets make dollar transactions possible at any time at low costs.

All of these functions reinforce each other. Therefore, a monetary standard can be established, which once is established, not so easy to replace with a new one. Such a change in the currency standard only happens every few generations - most recently after the First World War, as the British pound gradually lost its internationally dominant role. The decline of the pound as world money was preceded by a long relative decline of the British Empire. Other powers caught up economically and militarily, especially the USA and the German Reich. But the pound and the financial center of London remained the financial center of the world for quite some time.

Memories of the present are awakened. Where are we today?? Is the dollar a world currency on demand?

In any case, freezing the Russian central bank balances has the potential, endangering confidence in the dollar as a reserve currency. Even more: This would also damage the dollar's other international functions. It has already lost considerable popularity as a trading currency; other currency areas (EU, China) now handle larger trading volumes than the USA, increasingly in euros and other currencies. Many central banks have been trying to do this for years, to achieve a broader diversification of their reserves. Gold also plays a role, although quite difficult to sell, because the market is not particularly liquid, In any case, there is no comparison to US federal bonds (»Treasuries«). This slow move away from the dollar could be accelerated by central bank sanctions.

Certainly: Discussions, whether using the dollar as a weapon harms its status as a reserve currency, This also happened in the course of the measures against Iran under Trump. However, the scale and scope of the Russia sanctions are unprecedented. The question arises accordingly for countries with large currency reserves, whether their balances with the Fed (and other western central banks, who are now taking part in the sanctions) are still safe. Because – to put it cautiously – these are not all flawless democracies, the concerns are justified. The country with by far the largest foreign exchange reserves is China. The Saudis and the other Gulf emirates also have considerable dollar reserves.

It will have to be about that, Develop rules for the new monetary sanctions. Otherwise there is a risk of wild growth and arbitrariness. Under what conditions are central bank sanctions imposed?? Under what conditions will they be relaxed again?? There is still no clarity about this in the Russia conflict. But sanctions must be subject to conditions, so that they can trigger the desired behavioral changes. Facing an opponent, which is incalculable, the West must be predictable.

So far the dollar has benefited from this, that there are no real alternatives: The euro lacks an institutional foundation. Gold lacks liquidity; the renminbi is not even convertible, let alone underpinned by the rule of law; Cryptocurrencies are just a theoretical option, because they have the “soul of money” (BIZ Manager Agustin Carstens) missing, i.e. the trustworthiness of state institutions. But: digital currencies are developing rapidly, also driven by the central banks themselves – innovations, that can completely change the monetary system.
Added to this is the looming collapse of the world into blocks. It looks like this, as if China is on its way, to create your own hemisphere. The distrust in the dollar becomes too great, Beijing can develop alternative payment methods. After all, even the Soviets once managed it, their own pseudo-currency within their sphere of influence (»Transferrubel«) to establish, for deliveries within the »Council for Mutual Economic Assistance« (RGW) to be charged.

And then there is rising inflation. Nobody wants to hold a reserve currency for rainy days, if it is not reasonably stable in value. The Fed therefore has to act quickly, to get the price dynamics under control.

Ultimately, the financing of the entire US economy depends on the status of the dollar. That the United States is capable, long-term performance balance- and running budget deficits – and that means: to live structurally beyond their means –, is because, that half the world is ready, To lend America money at very low interest rates. This country, the then French Finance Minister Valéry Giscard d’Estaing complained in the 1960s, enjoy an “extraordinary privilege”. Various crises and wars later, little has changed.


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